Glossary
Inverse ETF
An ETF designed to return the opposite of an index's daily move, using derivatives; it decays when held over volatile periods.
On this page
An inverse ETF is an exchange-traded fund built to deliver the opposite of an index's return for a single day: if the index falls 1% today, a −1x inverse fund aims to rise about 1%. Some products use −2x or −3x multiples. They give a way to profit from, or hedge against, a decline without opening a margin account to short sell, but the daily target makes their results over longer periods unpredictable.
How it works
The fund holds swaps, futures or both, and resets its exposure every day so that each day's return matches the target multiple. That reset means returns compound daily, and the result over weeks or months is not simply the opposite of the index's return.
The more volatile and directionless the index, the larger this drag. In a steady, one-way decline the compounding can work in the holder's favor, so the outcome depends on the path, not just the start and end.
What to watch for
FINRA has warned since 2009 that inverse and leveraged funds are generally designed for holding periods of a day and may not suit buy-and-hold investors. Expense ratios are usually much higher than those of plain index ETFs. Losses on a −1x fund are capped at the amount invested, unlike a short sale, but a steady market rally erodes it steadily.